Hello. Thank you for standing by. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hexcel Q4 2021 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session.

[Operator Instructions] Thank you. I would now like to turn today's call over to Mr. Patrick Winterlich, Chief Financial Officer. Please go ahead, sir..

Thank you. Good morning, everyone. Welcome to Hexcel Corporation's fourth quarter 2021 earnings conference call. Before beginning, let me cover the formalities. I want to remind everyone about the safe harbor provisions related to any forward-looking statements we may make during the course of this call.

Certain statements contained in this call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

They involve estimates, assumptions, judgments and uncertainties caused by a variety of factors that could cause future actual results or outcomes to differ materially from our forward-looking statements today. Such factors are detailed in the company's SEC filings and last night's news release.

A replay of this call will be available on the Investor Relations page of our website. Lastly, this call is being recorded by Hexcel Corporation and is copyrighted material. It cannot be recorded or rebroadcast without our express permission. Your participation on this call constitutes your consent to that request.

With me today are Nick Stanage, our Chairman, CEO and President; and Kurt Goddard, our Vice President of Investor Relations. The purpose of the call is to review our fourth quarter 2021 results detailed in our news release issued yesterday. Now, let me turn the call over to Nick..

Thanks, Patrick. Good morning, everyone, and thank you for joining us today as we share both fourth quarter and full year 2021 results. When we spoke a year ago, the pandemic had a tight grip on both our business and our personal lives.

Last January, less than 1% of the world's population was fully vaccinated against COVID, international travel was at a virtual standstill, a large portion of our salaried workforce at Hexcel was working remotely and our great customer relationships had taken on a new dimension via various video platforms.

Like many businesses, we have learned quickly to work differently and effectively. We never forget, however, that Hexcel is a technology manufacturing company, and we believe strongly in the value of in-person interactions, driving collaboration and innovation.

Our production facilities have kept operating throughout the pandemic, albeit at lower capacities. Now, since the end of last summer and aside from any specific country or state restrictions, all our sites and offices are back in person on a regular basis, providing the most effective foundation for Hexcel to grow strongly once again.

And with almost 4 billion people fully vaccinated around the world, and air traffic in the U.S. alone back to more than 2 million people a day, I am optimistic that strong growth lies ahead.

Certainly, there are lingering effects from the pandemic affecting our business, including challenges for certain aircraft programs, supply chain constraints, hiring and retaining top talent and inflationary pressures. Yet we are determined to address and overcome these and other obstacles we may face.

Our focus is set firmly on a steep growth trajectory in 2022. Our primary challenges are the kinds of challenges we like to have such as how to ramp up quickly to meet an increase in demand that started late last year and is continuing as we start 2022.

When the pandemic drove a decline in demand from lower aircraft build rates and our customers' destocking in 2020 and early 2021, Hexcel kept moving forward. We responded quickly by making tough decisions, including restructuring the business, idling assets, reducing overhead and rightsizing our workforce.

Throughout 2021, and despite the uncertainty and the difficult decisions we took, the Hexcel team accepted and embraced the challenges we faced, quickly developing options and taking decisive actions. They knew what needed to be done, and they did it.

They quickly realigned our business for lower market demand while expecting nothing less than excellence in everything we do.

I'd like to take a moment to thank our Hexcel team for making 2021 our safest year in recent history, considering their extra workloads after our reductions in force plus complex equipment restarts and many new hires who still are learning their jobs. Our team's commitment to working safely is phenomenal.

It is clear as we share our Q4 and full year results that Hexcel begins 2022 on a firm base, better and stronger than ever, lean and aligned with demand and ready for a return to growth. Now, let me turn to our results. First, I'll cover the fourth quarter results and then full year 2021.

Fourth quarter sales of $360 million were almost 22% higher than Q4 2020. Adjusted fourth quarter diluted EPS was a positive $0.16 compared to a negative $0.18 last year. Turning to our three markets. A promising recovery is emerging in Commercial Aerospace.

Fourth quarter sales increased almost 59% in constant currency when compared to Q4 2020 and increased 19% sequentially over Q3. Contributing to the increase were higher narrow-body sales, increased Airbus A350 sales and higher business jet sales. We have now realized two consecutive quarters of double-digit sales growth in this market.

In Space & Defense, sales of $106 million represented an 11% drop in constant currency compared to our very strong fourth quarter last year. In the second half of 2021, we had some softness in legacy military and civilian rotorcraft as well as space programs.

Sales for the F-35, CH-53K and A400M programs were up in the fourth quarter compared to the prior year period. As we begin 2022, our outlook for Space & Defense remains positive. Industrial sales increased almost 13% in constant currency during the quarter to $55 million.

Strength in the automotive and recreation markets as well as other Industrial markets drove the increase, partially offset by lower wind energy. Now, let me turn to some specifics in our full year 2021 results. Sales were $1.325 billion, down 12.6% year-over-year in constant currency.

However, adjusted diluted EPS for the year was $0.27 compared to $0.25 in 2020 on roughly $175 million of lower sales. Improved adjusted EPS on lower year-over-year sales was achieved through our team embracing the pandemic challenges and driving efficiency and productivity.

In our markets, Commercial Aerospace sales represented 50% of our total sales for the year and were about $668 million, a decline of about 19% compared to 2020, which was only partially impacted by the pandemic. The decline was a result of lower commercial aircraft build rates and a period of inventory destocking by our customers.

Sales to other Commercial Aerospace declined less, yet still were about 12% lower than 2020. We're encouraged as we begin 2022 by strong order activity for the narrowbodies and by favorable developments regarding the 737 MAX return to service in China.

Our two largest Commercial Aerospace customers, Airbus and Boeing delivered 951 aircraft in 2021 combined, up significantly from 2020.

Airlines are also ordering again as they refresh and increase their fleets for growth, fuel efficiency and emissions reductions, and we believe that trend will continue driving the demand for lightweight Composite Materials.

As a reminder, we disclosed in previous calls that we have been transitioning some less complex engineered product work out of our Kent, Washington facility for Boeing to our 50-50 joint venture with Boeing called ACM or Aerospace Composites Malaysia. This transition was completed at the end of 2021.

The shift impacts 737 MAX sales and shipset values and has a relatively small impact to the contribution margin of the 737 MAX program.

It is an exciting new chapter for our Kent site as we transition toward more advanced composite production technologies including larger, more complex parts that leverage our processing expertise and nondestructive testing capabilities. Already, we have started to fill the extra capacity at Kent with new contracts for higher-margin growth programs.

Space & Defense sales of about $435 million reflected a 3% year-over-year decline. If this market remained relatively strong throughout the pandemic, and accepting some quarterly lumpiness, we expect it will continue to grow steadily in the medium to long term.

Hexcel composites are the benchmark in this market with our products on over 100 programs, which provides us a diversified foundation for strong growth. We'll strengthen our leadership position in this market, not only through our technology, but also our strong customer relationships.

At year-end, we saw market share gains of some new and extended contracts, so we have great confidence heading into 2022. Industrial sales of almost $222 million or a 7% year-over-year decrease in constant currency. Lower wind energy sales were partially offset by other industrial markets, including automotive and recreational.

For 2021, wind energy sales decreased about 38% in constant currency compared to last year. However, we have been very pleased with our ability to divert some of our spare capacity toward new revenue opportunities in this market space. We are reinstating guidance as we see more robustness in our end market recovery.

As you read in our news release last night, we are guiding to $1.50 billion to $1.63 billion in sales for 2022 with adjusted diluted earnings per share of $1 to $1.24. Our guidance on free cash flow is to generate more than $145 million while continuing to manage accrued capital expenditures with approximately $75 million of spend forecasted.

As part of our normal ongoing process, we regularly review the information that we provide publicly. As a result of our most recent review, we are moving away from providing specific platform shipset values for Commercial Aerospace programs. Instead, we're going to provide shipset ranges for those and additional programs.

Shipsets can vary among configurations based on seating capacity and use such as whether they are configured for passenger or freight.

Shipset values can also fluctuate as more composites are integrated into aircraft design and as customers become more efficient and more productive using advanced Composite Materials, further encouraging adoption and replacement of models.

This is a process we proactively support by providing new creative solutions that improve costs, material processing time to help define future and next-generation materials.

We believe the ranges will provide a better long-term perspective of our value proposition across a larger number of programs, including for the first time, some select defense platforms.

These new ranges will now include the Airbus A220 as well as large cabin composite-rich business jets that have shipsets ranging from $200,000 to $500,000, joining the Airbus A320neo family and the 737 MAX family in the shipset range.

The Boeing 777, 777X and 787, along with the Airbus A330neo, are in the shipset range of $1 million to $2 million, and the Airbus A350 with Hexcel carbon fiber used on the wing and fuselage, is between $4.5 million and $5 million, including the 900, 1,000 in freighter configurations.

Finally, I will share on this call shipset ranges for some of our top military programs to illustrate our growing and strong positions in Space & Defense as well as our progress towards deepening composite penetration in this market. Legacy programs such as the Black Hawk helicopter and Rafale Fighter jet fall in the range of $200,000 to $500,000.

The F-35 is our largest military program with an individual shipset per aircraft between $500,000 and $1 million.

More significant military programs by shipset value are the heavy lift A400M transport aircraft and the V-22 Osprey tilt rotor aircraft, which have shipsets in the range of $2 million -- a range of $1 million to $2 million per aircraft and illustrate the future growth opportunity from what will become a top program as production rate increase.

Our ship set on the CH-53K heavy lift helicopter is between $2.5 million and $3.5 million, with some variation depending on whether we produce the entire blade set or that aspect is performed in-house by the OEM.

Before I turn the call over to Patrick, I'm particularly pleased to highlight that our Board reinstated a dividend based on our confidence that our business has emerged better and stronger from the unprecedented events of the past two years and is planning for strong growth in the coming years.

Now, I'll turn the call over to Patrick to provide more details on the numbers..

Thank you, Nick. As a reminder, the year-over-year comparisons are in constant currency. The majority of our sales are dominated in dollars. However, our cost base is a mix of dollars, euros and British pounds as we have a significant manufacturing presence in Europe.

As a result, when the dollar strengthens against the euro and the pound, our sales translate lower, while our costs also translate lower, leading to a net benefit to our margins. Conversely, a weak dollar is a headwind to our financial results. We hedge this currency exposure over a 10-quarter horizon to protect our operating income.

Turning to our three markets. Commercial Aerospace represented approximately 56% of total fourth quarter sales.

Fourth quarter Commercial Aerospace sales of $199.7 million increased 58.7% compared to the fourth quarter of 2020 with growth in all three categories, including narrowbodies, widebodies and business jets, and we remain aligned with our customers on their publicly stated production rates.

Space & Defense represented 29% of fourth quarter sales and totaled $105.9 million, decreasing 10.8% from the same period in 2020. Softer space sales and lower military and civilian rotorcraft sales drove the decrease, partially offset by stronger F-35 sales. Industrial comprised 15% of fourth quarter 2021 sales.

Industrial sales totaled $54.7 million, increasing 12.8% compared to the fourth quarter of 2020. We experienced strength across a variety of markets, including automotive and recreation as well as consumer electronics.

We are continuing to experience subdued wind demand with the wind energy representing approximately 35% of fourth quarter industrial sales. On a consolidated basis, gross margin for the fourth quarter was 19.2% compared to 10.3% in the fourth quarter of 2020.

Growing contribution from higher sales combined with disciplined efficiency and productivity management is driving the higher gross margin.

We continue to do a good job mitigating inflationary pressures as most of our significant raw material purchases, including resins and fibers are typically under long-term contracts and industrial resins typically have pass-through mechanisms.

We hedge our acrylamide trial purchases and we have long-term contracts for power and natural gas at many of our sites. However, given the exceptional level of inflation in the general economy, we do expect to feel some margin pressure where inflation impacts minor raw materials and consumable items.

As a percentage of sales, selling, general and administrative expenses and R&D expenses were 12.2% in the current quarter compared to 12.3% in the fourth quarter of 2020. Note that in the fourth quarter of 2020, we still had some temporary compensation and benefit reductions instituted as part of our cost control actions.

Adjusted operating income in the fourth quarter was $25.2 million or 7% of sales. The year-over-year impact of exchange rates in the fourth quarter was favorable by approximately 100 basis points. Now turning to our two segments.

The Composite Materials segment represented 80% of total sales and generated an 8.7% operating margin, strengthening year-over-year on higher sales that supported increased capacity utilization. The operating margin in the comparable prior year period was negative.

The Engineered Products segment, which is comprised of our structures and engineered core businesses, represented 20% of total sales and generated a 4.2% operating margin. The operating margin in the comparable year period was 8.6%.

The quarter included an adjustment to the allocation methodology for stock compensation that resulted in a year-to-date catch-up in the fourth quarter that better presents the amount between the two segments and corporate.

Without this adjustment, the Q4 operating income margin for Composite Materials would have been 9.9% and the Q4 operating income margin for Engineered Products would have been 5.4%. The effective tax rate for the fourth quarter of 2021 was 19.3%. For full year 2021, the effective tax rate was 26.9%.

The pandemic and consequent weighted mix of results across the countries in which we operate, impacted the Company's overall effective tax rate throughout 2021. Net cash generated by operating activities for 2021 was $151.7 million. Working capital was a cash use of $18.3 million, increasing modestly to support growing sales.

Capital expenditures on an accrual basis were $41.4 million for fiscal year 2021 compared to $42.5 million for 2020. We continue to tightly manage capital expenditures with a focus on improving existing asset efficiency and new technology advancements.

Free cash flow for the fourth quarter of 2021 was $74.6 million and was $123.8 million for fiscal year 2021. Expanding profitability combined with closely managing capital expenditures drove the strong free cash flow generation and more than covered the modest working capital increase that is supporting the growing sales.

In 2020, free cash flow generation was $213.7 million, which was driven by working capital reductions on substantially lower sales as customers and the supply chain destocked. As Nick said, the Board has reinstated a dividend based on our confidence and expected free cash flow generation has returned to growth.

This action is also consistent with gradually returning to our pre-pandemic practice of returning a portion of our net income to shareholders. Our share repurchase program is restricted through March 31, 2022, by the revolver amendment executed in January 2021. Finally, I would like to share some additional detail regarding our 2022 guidance.

As Nick stated, we are forecasting sales in the range of $1.5 billion to $1.63 billion, adjusted EPS in the range of $1 to $1.24 and free cash flow is forecast to exceed $145 million.

Accrued capital expenditures are forecast in the range of $75 million as we grow back into our existing capacity and construct our new R&T innovation center in Salt Lake City and expand our engineered core plant in Morocco. We expect full year 2022 Commercial Aerospace sales to comprise approximately 55% of total sales.

Our sales forecast are based on publicly stated OEM aircraft build rates and expectations. We expect Space & Defense to comprise approximately 30% of total sales. We expect industrial to comprise approximately 15% of total sales. Additionally, we expect depreciation to generally remain similar to 2021 levels.

Consistent with prior years, selling, general and administrative expenses are forecast to be higher in the first quarter of 2022 compared to following quarters, reflecting the timing of recording stock-based compensation expense. Continuing on this seasonality, we expect free cash flow to be stronger in the second half of the year.

Our 2022 foreign exchange exposure is approximately 75% hedged today. We estimate that a 5% movement in relevant exchange rates would have approximately a $3 million impact to earnings net of our hedges. We expect the effective tax rate to be approximately 23% for 2022.

I also want to highlight that in 2022, we expect cash taxes to increase due to revenue growth and changes to U.S. tax treatment of R&D expenses as a result of the 2017 Tax Cuts and Jobs Act. With that, let me turn the call back to Nick..

Thanks, Patrick. For many years, sustainability has been a core element of Hexcel's business proposition. As the latest step in this journey, we recently made our 2030 sustainability targets public on our website and our teams are sharing these targets with our customers.

These long-term goals span several foundational pillars with measurable milestones for reductions in greenhouse gas emissions, landfill waste and freshwater usage. We also are committing to continued improvements in workplace safety, diversity, inclusion and community involvement.

At Hexcel, sustainability is about making responsible products in responsible ways, supported by a diverse One Hexcel team that is propelling us towards a better tomorrow.

These goals will guide our initiatives, foster greater transparency and accountability and allow us to track progress through specific time-bound objectives that are aligned with our strategic planning processes. I look forward to sharing progress with you as we continue this journey.

While there is still uncertainty around some aerospace programs, along with some supply chain constraints and inflationary pressures, there are also many encouraging signs as air travel recovers and airlines are clearly refreshing their fleets with fuel-efficient, lower emissions aircraft made possible by the solutions Hexcel offers.

Future challenges are inevitable, pandemic related or otherwise. However, Hexcel will always continue to control our destiny by staying focused on efficiency and productivity, cash management, and overall performance, especially in quality and on-time delivery.

Global demand for advanced composite technology for lightweight, stronger and more durable materials in all of our markets will only grow. And our technology and products remain unrivaled in our industry. The potential for a significant upturn in 2022 and beyond looks very promising.

The disciplined actions we have taken and will continue to take will ensure that Hexcel emerges from this pandemic stronger than ever, providing long-term shareholder value. Brent, that concludes our prepared comments. We're now ready to take questions..

[Operator Instructions] Your first question comes from Mike Ciarmoli with Truist Securities..

Hey. Good morning, guys. Thanks for taking the question. Nice results here and glad to see the guidance back. Maybe just, I guess, as we think about '22, I guess, the embedded outlook calls for about 30% growth in aerospace.

How are you guys -- or how should we be thinking about the excess capacity and maybe still idle assets tied to the widebody side of the business, I mean, we've obviously heard from Boeing.

Is that going to be -- continue to be a drag on margins as we go throughout the year? Are you going to be able to repurpose some of that capacity? Just how should we think about that?.

So Mike, thanks for joining. Our assets that were idle as a function of the demand drop was very significant in 2020, and we have steadily been bringing them back on line. So it's not a big bang approach. It's as the demand comes back, we're methodically bringing those lines back on with trained and talented resources.

During the course of the correction, we have also targeted to find new avenues, new areas of opportunity to sell our fibers and our materials. And the team has done a fantastic job in doing that at very nice and certainly very acceptable margin levels. So, I would see that journey continuing as we ramp through 2022.

Again, we do not need to bring on any new assets in the foreseeable future. It's just a matter of basically repurposing the assets that have been set idle and bringing them back on line for the future..

Got it. Just a quick follow-on. Any mix issues we should be aware of as the aero ramp continues, we -- I think you've kind of said in the past, margins could be a bit volatile quarter-to-quarter.

Is there anything you guys are looking at that would be a little bit more dilutive on that structure weaving side, or anything we should be aware of there?.

Hi Mike, nothing too specific. I mean, we have called out that we have -- mix is volatile. We've seen some very nice quarters. I think Q3 was especially strong in 2021. I would any marginal -- any margin dilution will be limited. We obviously started very strongly with carbon fibers.

And we've said that may come down a little bit over time in the overall picture. But it's nothing too dramatic, and I wouldn't overplay it. So we won't see quarter three type margins every quarter. Life is not a straight line.

But fundamentally, as volumes grow and we get the top line leverage, the trend of our margins will continue to be upwards for the next two, three years as we grow back..

Your next question comes from Robert Spingarn with Melius Research..

I thought maybe I'd ask some strategic things, especially given just the long-term potential here. And so, I wanted to touch on something that Stan Deal talked about from Boeing in the Seattle Times.

He talked about a new gross weight version of the 787-10 to compete against the A350-900, and wondering to what extent this might provide incremental opportunity for Hexcel?.

Well, Rob, we've said it before. Any time there's a derivative engine or aircraft or a new engine or aircraft, we expect our content and position to grow significantly. Again, stating the obvious, lightweight materials, composite materials are a huge enabler for efficiency and sustainability going forward.

So again, I'm not going to get into details on what a 787 refresh might look like, but I'm pretty convinced it will be more composite-intensive especially as the technology has continued to evolve, and near net shapes and the processing just allows more and more secular penetration into those platforms..

No, maybe shifting slightly, can you update us on your research efforts to support high volume out of autoclave parts that might be targeted, for example, at narrowbodies in the future where composites haven't been as heavy or rather as used, actually a better word in the past?.

Yes. So again, that's one of the areas we're so proud of and why we talk about our unrivaled portfolio. We have multiple options for advanced materials that utilize both out of autoclave and in autoclave. I don't think it's going to be a total conversion.

I think it will be a migration based on the application, but we have some very productive, very exciting materials that certainly can be cured outside of autoclave much quicker, much more effectively with less waste, allowing those to penetrate the narrowbodies. And as we even called out, the composite-intensive large cabin business areas..

Your next question comes from the line of Robert Stallard with Vertical Research..

A couple of questions on the widebody front. First of all, for your 2022 guidance, thanks so much for bringing it back. What have you built in there on the 787, obviously, given the uncertainties there? And then secondly, you called out the A350 growing year-on-year.

Is that basically the end of destocking, or are you starting to see a bit of restocking in preparation for that rate to be a bit higher?.

Yes. So, I'll hit the 787 first. We're aligned with Boeing. We're shipping at a very low monthly rate. I assume many of you participated in the Boeing call yesterday, I can just tell you our guidance embeds their assumptions going forward, and we think we're very well positioned.

Another one of the reasons on why we opened up our range a little bit more this year than maybe we have historically. So, we think we're aligned certainly rooting for Boeing to get the FAA recertification to be able to start delivering again and producing back up to a rate of 5.

On the A350, the destocking is behind us, and that provided what we believe is the majority of the growth in Q4, that will continue into this year. And then as Airbus ramps up to go up 1 plane per month, we'll get that -- or that tailwind in the second half of this year..

Your next question comes from the line of Ken Herbert with RBC Capital Markets..

I just wanted to follow up on the guidance for your Space & Defense. I mean it looks like you -- the guidance implies about a high single-digit recovery in top line in '22 after some of the issues in '21. What can you point to in terms of the upside? Is it -- I know you've talked in the past about F-35 and CH-53K.

Is it those programs? Are you seeing anything else? Any more granularity on the Space & Defense outlook would be great..

Yes. Hi Ken. I mean, you're right. If you take our midpoint, you're going to back into about 8% year-over-year growth. '21 was obviously down about 3% over 2020. So essentially, we're catching that up and then growing beyond it. The primary drivers are, as you call out, the F-35, where there were 10 or a dozen push from 2021 into 2022. So that helps.

And the CH-53K. And then clearly, we've just sort of -- Nick has called out the shipset there, so you can see the significance of it. As that now starts to grow and double roughly every year as we go forward for the next sort of 2 to 3 years, those are the key drivers.

Now, the future vertical lift programs have some way to go, but there will be more material that continues to supply the early sort of prototyping, which is going to help. And most of the other programs run at a steady state with some lumpiness. We did see some softness in some of the legacy programs towards the end of 2021.

But fundamentally, we continue to be optimistic for a longer term, medium term, low single growth for several years to come..

Your next question is from the line of John McNulty with BMO Capital Markets..

Congratulations on some solid results. And I guess to that, our question is really on the free cash flow side and your balance sheet. So, cash flow was stronger in the quarter than expected. And at least based on the guide, it looks like your balance sheet in terms of leverage will be maybe arguably under 2 times by the end of 2022.

So, can see some of that cash going forward is going in the dividend. But I guess, can you help us to think about where else, as the year progresses, free cash and some of that excess balance sheet strength can go to? I know you've got some issues around covenants that I think you clear by the middle of the year.

So after that, can we see buybacks? Do you see an M&A pipeline? I guess, how should we be thinking about that?.

Yes, all of the above in one sense. But yes, we're confident to generate significant cash now going forward. We forecast greater than $145 million, and we'll be driving to push that as strongly and as high as we can. As the top line grows, we -- working capital will be a headwind again. I mean, our receivables and our inventory will continue to step up.

So, we need to manage that in a disciplined way, sort of relative days is the way we sort of choose to do that. Capital expenditure will be managed tightly. We're kind of getting back, I guess, to sort of what we used to call a maintenance level of spend.

We've called out the R&T center and the expansion in Morocco, which is a bit of a longer-term ongoing program. So, we balance those things. The organic growth is covered. As Nick said, by and large, we're growing into existing footprint. So that then leaves the cash that we have. We have to work within the covenants.

We will revert to the leverage ratio of gross debt to EBITDA on June 30th at the end of the second quarter. We need to be under 3.75. We should be comfortably under that, and we will then work it down as our EBITDA grows.

I mean, just to point out, we have reduced net debt by $300 million between the end of 2019 and the end of 2021, which I think is a tremendous performance over the last two years. So yes, we've announced a dividend at $0.10, so $8.5 million or so a quarter. And as the year goes on, we will look at both M&A opportunities.

We'll be disciplined, but we would love to do another sort of ARC Technologies type acquisition, high technology, good margins and integrate that into Hexcel. And going forward, we should have the capacity to look at that at least something that size or larger.

And then, yes, stock buyback, perhaps the last sort of piece of the equation, as and when we have that confidence in our cash generation, I'm sure that will come on to the agenda as well..

Got it. And maybe with just a quick follow-up. With regard to the 2022 guidance, it looks like it implies about a 30% incremental margin on the sales that you're bringing in, give or take a little bit.

Is that the right way to think about the incremental margins going forward, or are there some puts and takes this year that may either skew that a little higher going forward or a little bit lower? I guess, how should we be thinking about that?.

Well, I don't know if that's a trip hazard, John, but I'm not going to commit to a number. We're just going to drive our incremental leverage as strongly as we can. As you've seen, it's very high. It's historically high in 2021.

And for the next year or two, it's certainly going to be above what you see as a historic norm just because of the growth leverage we're seeing double-digit -- high double-digit growth for two or three years. We're going to drive our incremental leverage through efficiency and productivity as strong as we can.

What I would call out is sort of a double-digit plus operating income target this year as we go into 2022..

Your next question is from the line of Pete Skibitski with Alembic Global..

Just follow-up on the nice cash flow guidance for 2022. Patrick, you talked about the cash tax headwind from the law change.

Can you quantify that for us, the impact in 2022? And then, maybe how it kind of rolls down in '23 and '24, just going to have a sense of the non-operating dynamics?.

Yes. I mean, it's fairly marginal in truth. We called it out. We are -- I mean, it's the growth in net income that's going to drive most of the increase in our cash taxes. The switch, I mean, very broadly half of our R&T spend is in the U.S. So that would be, what, $23 million or so in 2021.

So if you imagine half of that, we can now only take 20% as a deductible. That's going to impact us what, a couple of million dollars, $2 million, $3 million each year. You then kind of add back another 20%. So in 5 years' time, it becomes a nonevent if it's not repealed, which hopefully, it will be. So the R&T tax impact is marginal, Pete.

The bigger impact is from our income growth on cash taxes..

And then just last one for me on FLRAA, Future Vertical Lift. I guess, there is supposed to make the award this year.

Does it matter to you guys, which team wins? And are they both potentially sizable content for you? And could this be sort of your largest -- could it be as big as the F-35 for you guys lifetime?.

So, we're not picking a winner. We're -- we have great content on both platforms, and we're supporting both of the teams. And I will tell you, it will be a nice program regardless for us once that gets awarded and starts ramping up..

Your next question is from David Strauss with Barclays..

So, you previously spoken, Nick, about getting back to mid-teens margins, $1.9 billion in revenue.

Is that still the right way to think about it, given some of the inflationary pressures you highlighted today?.

It is. It is. Our mindset and what we're seeing today based on the restructuring, the process and productivity improvements we've made. Today, we're pretty comfortable that that will offset the inflationary pressures we're seeing, and that's still our target to get to that level of operating margin percentage in that sales range..

Okay. And Patrick, you highlighted the good cash performance here over the last two years. Obviously, you've had a big working capital tailwind looks like $150 million or so.

How much of that comes back into the business as we ramp back to, call it, this $1.8 billion, $1.9 billion in revenue level?.

How much working capital?.

Yes, how much is working capital kind of drag on the cash flow profile as revenue starts to ramp back up? I assume you have to add some working capital back to the business..

Absolutely. And I think I said that a moment ago. I mean, if you think we took out about $115 million, $120 million of working capital in 2020, I mean in simple terms, if our sales get back to $2.4 billion, a very large portion of that is going to come back. Now, we'll try and minimize that.

We'll try and be efficient and disciplined with inventory and always do our best job on collections. But as the top line grows, you necessarily will carry more working capital, but we'll obviously try and be as efficient and drive those days, those relative days of sort of receivables, relative days of holding inventory, keep that as tight.

But you can imagine, as we grow back to $2.3 billion, $2.4 billion, a lot of that working capital will come back. It's going to come back over several years, but it will come..

Okay. And Nick, last one on A350, you talked about growth there this quarter. Obviously, the rate, I don't think has actually gone up yet. So I assume that's just a bit of restocking.

I mean, how much upside you actually have you think from restocking before you actually see the benefit of a higher rate there?.

Well, I don't know if it's so much restocking, David, that helped us in the fourth quarter. It was more a point of the supply chain had equalized to the lower range. And the destocking stopped and we caught up to the current 5 per month rate. So again, we're 4 to 6 months ahead of Airbus.

I would think the added rate would start hitting us in Q3 type time frame..

Your next question comes from the line of Richard Safran with Seaport Global..

I came a little late. So, if you covered this, I apologize. I think you've noted, and it was really expected once the business recovered and grew that you'd have to increase the workforce and grow overhead. That impacts, I think, some portion of the $150 million in cost savings.

I thought you might talk a little bit about growth in the workforce, overhead growth.

And if you could discuss what part of the $150 million you think might be a permanent savings?.

Yes. So, we've called that out. We achieved $150 million thereabouts, which was our target in cash cost savings. As the business now grows back and the challenges operationally increase, the overhead base will naturally have to go up. We will try to be as disciplined as possible.

What we've called out sort of again, in reference to the $1.8 billion, $1.9 billion revenue scenario where we had about $60 million, $65 million less depreciation last time we had that level of revenue. Our clear target is to hold on to at least that much of the cost takeout. So, that's what I would speak.

Half or a bit more of those cost savings are likely to come back. We definitely are challenging ourselves to cover that depreciation overhead -- that depreciation headwind through efficiency, productivity, technology and all those good things that we're working on all the time..

Okay. Shifting gears to industrial, industrial end markets and expectations '22 and longer term. I'm interested to know about growth expectations are, for example, for automotive long term.

Do you think at some point, automotive offsets wind? Are the opportunities you're pursuing likely to drive better margins here? I was just curious about how you're seeing that play out..

Yes. So again, we're excited with the growth we're seeing in automotive. We're excited with what we're seeing in marine and some of our new technologies and the adoption and how we're helping customers provide more efficient solutions. We still are a -- we're not a commodity material provider.

We're focusing on the high end, the European-branded automotive applications where we can provide a competitive advantage, whether it be structural, weight for -- lightweighting for electrification or performance. Those are really the areas we're focusing on. And those margins are quite nice. So, I think we've taken a very disciplined approach.

I don't see it changing the complexion of our business mix between aerospace, space & defense, and industrial. But I do think it's a growth platform that we're going to continue to pursue and continue to have opportunities to grow..

Your next question comes from the line of Gautam Khanna with Cowen..

Patrick, could you elaborate on what has changed with the JV? I'm just curious if the work that's moving out of Hexcel into the JV and what the EBIT impact, if there's any round numbers you could give because I presume you're going to get some equity income, but on the other hand, if the work is not captive to Hexcel, I would imagine it's a net reduction in EBIT related to the JV.

So what sort of changed on January 1st with respect to that arrangement?.

Well, what changed on January 1st was the end of a two-year journey really or multiyear journey to transition that product out of our Kent, Washington facility over to the joint venture. I mean, it took a lot of planning and efforts and training and education to move it over.

But it was less complex, lower skilled work, lower margin, I mean, still decent, but lower margin work that has moved into the JV. And it just made sense after 20 years for that evolution to happen. We are going to work first and foremost, very hard, and we're already seeing it, to put new programs into that Ken, Washington facility.

Military platforms and other, which are going to bring very good business, strong new opportunities, which is going to actually raise I would imagine, the average margins out of that Kent facility. In the JV, we're a 50% partner. And yes, we received 50% of the profit after tax, the residual income. And we expect that plant to actually grow.

It's a very efficient at what it does sort of more simple build-to-print type work, it's become more and more expert over the years. So, it's a good transition. We've worked very positively with Boeing on the transition, and we're pleased on the outcome. I mean, I'm not in a position to give a specific EBIT up or down number.

But fundamentally, as I say, it's lower-margin work that's moved out, and we'll be moving new packages and new production opportunities at a higher margin into Kent over time..

Maybe asked a different way, is there a way to maybe quantify what that work -- that product accounted for in terms of revenues or something in 2021, just so we have a sense of what kind of headwind you're actually overcoming as you drive the growth into 2022?.

I mean, in 2020, I mean, if I go back two or three years, it was obviously a much larger number. But through the transition and then the pandemic, it's kind of softened greatly the year-over-year impact. But if I said it was in the order of $50 million that's now gone and that we are now replacing, that would probably shape it..

Your next question is from the line of Mike Sison with Wells Fargo..

Nick, good to hear you sound excited about pivoting back to growth here going forward. And just curious, could you remind us maybe how the backlog has sort of shaped up over the last year or so and how much growth that provides Hexcel over the next several years, backlog of customer planes that is..

Thanks, Mike. Well, as you've seen, the OEs and the airlines have started placing more orders, obviously, both at Airbus and Boeing, and that's adding to the backlog, especially during these lower production years. I am a believer that there is a fair amount of aircraft still parked.

And those aircraft, a large percentage of them are 15 years or older and probably much less efficient than new narrowbodies and new widebodies. And there's no doubt a percentage of those aircraft will be replaced by new.

And that's a good position because all of the new platforms, we have stronger positions than the old metal precomposite adoption era. So, I think the backlog is definitely very strong. As we see at both Airbus and Boeing, there's currently, a move to increase rates on the narrowbody.

Widebody is obviously waiting for the pandemic and the borders and the international travel to get back to reasonable levels, which we think will happen fairly soon. And then, those orders will continue to come in as well..

Your next question comes from the line of Myles Walton with UBS..

I was wondering maybe some color on the incremental margins sequentially through the course of the last few quarters. Obviously, the revenue has been growing nicely, particularly at Composite Materials, but the margins not really keeping that step sequentially.

I know there was a better mix in the third quarter, but also the trend sort of holds if you look second quarter through fourth quarter. So, maybe -- I don't know if it's Patrick.

Is there a mix benefit shift that occurs particularly in the first half of 2022 to get you to those double-digit margins?.

Hey Myles. Well, I mean, quarters are a bit lumpy. I mean, as I'm probably repeating myself, life is not a straight line. We're going to see steady general margin growth over the next two, three years as our top line gives us the leverage opportunity. Within that, yes, there is a mix impact.

I'm confident as we go into 2022, we're going to drive double-digit adjusted operating income margins, and that's our clear goal. Will every quarter be sequentially up? I can't guarantee and probably unlikely. But we're going to see good, strong margin growth and incremental margins as the year goes on.

And then, moving into 2023, they'll continue to grow. So, double-digit margins are clearly on our radar, Myles, is a simple way to put it..

Your final question comes from the line of Paretosh Misra with Berenberg..

Most of my questions have been answered, but maybe just going back to the labor headcount question earlier.

So, do you have currently plans to increase the labor headcount this year, or that's not in your plan for the year?.

Yes. I mean, absolutely, headcount is going to increase. I mean our direct headcount will increase sort of pro rata with our top line sales production, that will happen around our operations around the world. So, our direct labor, our variable cost labor.

Our overhead label will also increase to some extent, but we're going to operate in a very-disciplined way. And as we said before, hold on to the savings as much as possible through efficiency and productivity and using IT and technology to be more efficient. But I mean, headcount will go up as part of that overhead comeback.

But ultimately, we're looking to be more productive than we were before the pandemic..

Got it.

And so that's already baked into your guidance for this year, I guess?.

Absolutely, yes. Yes..

Ladies and gentlemen, thank you for your participation. This concludes today's conference call. You may now disconnect..